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| Informational Memorandum | |
| Subject: | USDA Guaranteed Investments |
| Date of Memorandum: | 03/22/2011 |
| Expiration Date: | |
| Office: | Office of Regulatory Policy |
| Signed By: | Van Meter, Gary |
| FCA Contact Person: | Gibbs, Paul |
| Contact Phone: | 703-883-4203 |
| List of Attachments: | |
March 22, 2011
To: Chairman, Board of Directors
Chief Executive Officer
All Farm Credit System Institutions
From: Gary K. Van Meter, Acting Director
Office of Regulatory Policy
Subject: USDA Guaranteed Investments
Introduction and Background
The purpose of this Informational Memorandum (IM) is to reiterate and clarify that Farm Credit System (System) institutions have broad authority to invest in obligations (including loans and bonds) that are fully insured or guaranteed by the United States Department of Agriculture (USDA) and its agencies. System institutions may purchase unconditionally guaranteed portions of loans/bonds in the secondary market using their existing investment authority.1 This investment activity supports the secondary market and helps to improve the flow of funds to rural areas.
The Farm Credit Administration (FCA) is committed to helping ensure a dependable source of credit for agriculture and rural America so farmers, ranchers, and their rural communities can flourish. System institutions can use their existing investment authority to help meet the financing needs of agriculture and rural America in the 21st century. These guaranteed investments can help increase the availability of long-term credit to farmers, ranchers, agribusiness, and other rural residents at stable interest rates. They can also help improve the liquidity of agricultural lenders, provide new capital for agricultural investments, and enhance the ability of individuals in rural communities to obtain financing for farmland and moderately priced homes. Further, such investments can also provide System institutions an additional tool to diversify the credit risk exposures in their agricultural loan portfolios.
Investment Authority
Under FCA regulation § 615.5140(a)(1), System institutions have broad authority to invest in obligations (including loans) that are “fully insured or guaranteed by the United States, its agencies, instrumentalities, or corporations.” This authority applies only to obligations that are unconditionally guaranteed as to both principal and interest by such entities.2 Farm Credit System banks may hold these investments in an amount not to exceed 35 percent of outstanding loans, to comply with liquidity reserve requirements, to manage surplus short term funds, and to manage interest rate risk.3 An association may hold these investments with the approval of its funding bank.4 System institutions may use this authority to support their mission objectives by investing in guaranteed agricultural, rural housing, rural utility, or rural economic development loans and other obligations made in accordance with the framework laid out in FCA Bookletter BL-064, Farm Credit System Investment Asset Management (December 9, 2010), under various programs of the USDA, which is an agency of the United States.
The USDA has several rural development programs, which provide guarantees, including (1) the Farm Service Agency (FSA), which provides credit for farm ownership and operating loans; (2) the Rural Utilities Service, which addresses rural America's need for basic services, such as clean water, sewers and waste disposal, electricity and telecommunications; (3) the USDA Rural Development, which addresses rural America's need for water and sewer systems, housing, health clinics, emergency service facilities and electric and telephone service; and (4) the Rural Business and Cooperative Service, which provides technical assistance and financing for rural businesses and cooperatives to create quality jobs in rural areas.
While the USDA guarantee significantly reduces the risk for all participants and provides a useful and effective risk management tool, not all USDA guarantees are unconditional. Servicing responsibilities of an originator (generally, the Lender of Record or bond servicing agent) make the USDA guarantee conditional. The “Lender of Record” as defined by the USDA is the person or organization making and servicing the loan or bond which is guaranteed under the provisions of the applicable subpart of 7 C.F.R. 1980. The Lender of Record is also the party requesting the guarantee. The guarantee is conditional because the Lender of Record requesting it must satisfactorily perform certain servicing requirements for the guarantee to remain effective. Negligent servicing is defined as the failure to perform those services which a reasonably prudent lender would perform in servicing its own portfolio of loans that are not guaranteed.
In contrast, System institutions that invest in portions of loans/bonds guaranteed by the USDA, have no servicing responsibilities and hold and maintain an appropriately documented assignment of guarantee (Holders) have an unconditional full faith and credit guarantee by the USDA that can be sold in the secondary market. The “Holder” as defined by the USDA is the person or organization other than the Lender of Record who holds all or part of the guaranteed loan or bond with no servicing responsibilities. When the Lender of Record assigns a part of the loan or bond to an assignee, the assignee becomes a Holder only when Form RD 449-36, “Assignment Guarantee Agreement,” is used. The full faith and credit obligation of the USDA is incontestable except for fraud and misrepresentation of which the Lender of Record or any Holder has actual knowledge, or which a Lender of Record or any Holder participates in or condones.
In addition to the general authority to invest in obligations fully insured by the United States or its agencies, instrumentalities or corporations, System institutions may hold other investments as approved by the FCA. Section 615.5140(e) states that “[y]ou may purchase and hold other investments that we approve. Your request for our approval must explain the risk characteristics of the investment and your purpose and objectives for making the investment.” System institutions have used this authority to request FCA approval of new investments that fund the needs of agriculture or rural America under certain conditions. For example, System institutions may invest in obligations that are guaranteed under USDA programs, including investments made under pilot programs approved by the FCA such as the Rural America Bond (RAB), Agricultural and Rural Community (ARC) bond and other similar programs.5 Importantly, System institutions that are not participating in these pilot investment programs still may purchase and hold USDA guaranteed obligations as discussed in this IM.
Investment Management
Sections 2.2(10) and 2.12(18) of the Farm Credit Act of 1971, as amended, require each System bank to approve the investment activities of its affiliated associations. Likewise, § 615.5142 authorizes associations to hold eligible investments with the approval of their funding bank. Nonetheless, this oversight requirement for System banks does not release an association’s board and managers of their duty to manage investments in a safe and sound manner.
System banks and associations also must establish investment management policies and practices that are appropriate for the nature and risk characteristics of their investment activities in accordance with § 615.5133. While the risk is considered to be well mitigated on those transactions where a System institution purchases the portion of a loan or bond that is fully guaranteed by the USDA, appropriate due diligence and analysis is still required for these transactions. FCA Bookletter BL-064 provides clarification and guidance regarding the FCA’s regulations and lays out the FCA’s expectations with respect to the key elements of a robust investment asset management framework that each System institution should establish to prudently manage its investments in changing markets.
Risk-Weighting
In order for System institutions to arrive at a “risk-adjusted asset” amount, § 615.5211 assigns balance sheet assets to various risk categories (e.g., zero, 20, 50, 100 or 200 percent). That risk-adjusted asset amount is then used to calculate various capital adequacy ratios.
As provided by § 615.5211(a)(3), System institution assets that represent “direct claims on, and portions of claims unconditionally guaranteed by the U.S. Treasury, government agencies, or central governments in other OECD countries,” are assigned to the zero percent risk category. System institutions that purchase instruments guaranteed by the USDA in the secondary market may assign those assets to the zero percent risk category as long as the guarantee is “unconditional.” For purposes of § 615.5211(a)(3), the USDA guarantee is unconditional if both the applicable regulations governing the loan guarantee program and the applicable loan, assignment, and secondary market documents provide the following:
· The loan or bond is secured by an assignment of the guarantee on appropriate forms from the USDA (Form numbers may vary by program).
· The System institution has possession/control over the assignment.
· The guarantee is incontestable except for fraud or misrepresentation that the holder participates in, condones, or of which it has knowledge.
· The validity of the guarantee is not dependent on any affirmative action (such as servicing or reporting) by the purchaser of the guaranteed portion of the loan in the secondary market.